Return on Assets (ROA)

Overview

Return on assets is a financial indicator that shows how profitable a business is in relationship to its total assets. In other words, how efficient a business is at using its assets to generate profit. The higher the return, the more efficient the management might be at using its resources.

It is important to notice that, unlike Return on Equity, the Return on Assets does take into account all assets regardless of liabilities to creditors. Therefore, the more leveraged a company is, the higher ROE will be relative to ROA. The reason for this is because when debt increases, equity decreases, and since equity is the ROE's denominator in the formula, ROE becomes larger.

Another way of looking at it is that Return on Assets shows how efficiently a company can convert the money used to purchase assets into profits.

Formula

Or using average total assets for more accuracy:

Net income can be found on the income statement, while total assets are found on the balance sheet. When using average total assets, calculate the average by adding beginning and ending period assets and dividing by 2.

Calculation Example

Let's calculate the return on assets for a construction company to demonstrate the process:

How to Interpret

Since return on assets is an efficiency ratio, the larger the ROA, the better and more efficient the company is at using its assets to generate profit. However, the ROA ratio is highly industry dependent.

General Guidelines:

Why It Matters

Return on assets is essential for investors, creditors, and management because it provides valuable insights into how efficiently a company is using its assets to generate profit and how that efficiency compares to industry peers.

Key Insights:

• Asset Efficiency Measurement: Shows how efficiently a company can convert the money used to purchase assets into profits. Higher ROA means management is more efficient at using its resources to generate returns.
• Comprehensive Asset View: Unlike Return on Equity (ROE), ROA takes into account all assets regardless of liabilities to creditors. This provides a more complete picture of how well the entire asset base is being utilized to generate profit.
• Leverage Impact Understanding: The more leveraged a company is, the higher ROE will be relative to ROA. When debt increases, equity decreases, and since equity is ROE's denominator, ROE becomes larger. Comparing ROA and ROE together reveals how leverage impacts returns.
• Capital Intensity Assessment: ROA reveals how capital intensive a business is relative to its industry. Capital intensive industries (construction, railroads) naturally have lower ROA, while asset-light industries (software, services) have higher ROA. This helps investors understand the operational model and compare companies appropriately.
• Comparative Analysis: Enables meaningful comparison of a company's historical ROA performance and benchmarking against comparable businesses in the same or similar industry to identify relative strengths and weaknesses in asset utilization.

Key Takeaways

• Return on assets is a financial indicator showing how profitable a business is in relationship to its total assets
• Measures how efficient a business is at using its assets to generate profit—higher returns indicate more efficient management
• Calculated as Net Income ÷ Total Assets (or Average Total Assets for greater accuracy)
• Unlike ROE, ROA takes into account all assets regardless of liabilities to creditors
• More leveraged companies have higher ROE relative to ROA because debt increases while equity decreases
• Shows how efficiently a company converts money used to purchase assets into profits
• Since it is an efficiency ratio, larger ROA is better—above 20% is considered very good
• ROA is highly industry dependent—capital intensive industries (construction, railroads) have lower ROA
• Asset-light industries (software, services) have much higher ROA due to lower asset requirements
• Essential to compare ROA with the company's historical performance and comparable businesses in the same or similar industry